Investors with limited knowledge who attempt to adopt an asset allocation strategy themselves run the risk of incurring losses if they are unable to assess the changing dynamics of an asset class.
Wealth creation is a long-term process. They say investing is a marathon, not a sprint. And rightly so, the longer you stay invested, the less impact short-term cuts/corrections have on your portfolio. While the power of compounding becomes potent as you invest over a longer time frame, events such as market corrections and black swan events put a dent in your corpus at least for the short-term period.
Historical data indicates that, during the period of deep cuts, the value of the portfolio can drop by as much as 60-70% (Source: NSE) from its immediately preceding maximum value. It is therefore necessary to have a strategy that can help investors through the cuts and the stock market crash without significant impact on their corpus.
Asset allocation is one such strategy that has stood the test of time to protect the corpus of investors and has led to long-term wealth creation. Asset allocation is an investment style in which investors diversify by investing in different uncorrelated asset classes, so that any sharp correction in one asset class does not have an impact in cascade over the other. In this style of investing, the investor aims to be opportunistic and moves from one asset to another based on their outlook on different asset classes.
There are many forms of asset allocation combinations currently available with asset classes based on investors’ risk appetite such as equities, debt, gold, commodities, currencies, real estate, real estate investment trusts (REITS), infrastructure investment trusts (InvIT), etc. One of the most important is investing in stocks, debt and gold, where investing in stocks is for capital appreciation, investing in debt for capital protection and gold as a safe haven. Another combination is Equity, Debt and Arbitrage Fund. Mutual funds today offer various asset allocation systems across different combinations of asset classes. The multi-asset allocation fund has proven beneficial over a longer period.
Adopting an asset allocation, however, is easier said than done. This involves having unparalleled knowledge and understanding of different asset classes. For example, which asset class to choose, what the asset allocation should be, when to enter which asset class and when to exit which asset class. Investors with limited knowledge who attempt to adopt an asset allocation strategy themselves run the risk of incurring losses if they are unable to assess the changing dynamics of an asset class. It is therefore advisable to follow the advice of the financial advisor or invest in Multi Asset Allocation / Dynamic Asset Allocation funds offered by various mutual funds.
The dynamic asset allocation fund by mutual funds could be a good option especially at a time when valuations are expensive. Some of the funds operate on a quantitative model to arrive at an optimal level of asset allocation. The model analyzes the evolution of the trend of the variables and calculates the optimal level of asset allocation. The main objective of these funds is to reduce the volatility of the fund through an optimal asset allocation. For example, when markets have high valuations, the model may suggest reducing equity exposure and allocating a higher proportion to debt. This protects the investment from any potential market correction. In the event of lower valuations or market corrections, the model may suggest an increase in equity allocation.
Asset allocation as a strategy has its advantage. However, this involves complex models and a superior understanding of different asset classes. Investors may consider investing in Dynamic Asset Allocation Fund/Multi Asset Allocation Fund offered by mutual funds professionally managed by trained fund managers.
(By Jaiprakash Toshniwal, Senior Equity Research Analyst and Fund Manager – Equities, LIC Mutual Fund Asset Management Ltd)
Disclaimer: The opinions expressed here are the personal opinions of the author and are based on internal data, publicly available information and other sources believed to be reliable. The information/data contained herein is not sufficient and should not be relied upon for the development or implementation of an investment strategy. Readers are encouraged to consult their financial planner before making any investment.
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